Blinder says Keynes is not Dead

Our Fiscal Policy Paradox

Government's kitbag is overflowing with ways to spur demand. Yet fiscal policy sits idle, paralyzed by extreme partisanship.

By ALAN S. BLINDER Opinion Wall Street Journal OCTOBER 25, 2010

The practice of monetary and fiscal policy is fraught with difficulties, but the central concept is straightforward, compelling and, by the way, 75 years old: The government should push the economy forward when unemployment is high and slow it down when inflation threatens.

To do so, governments normally have two principal sets of weapons. Fiscal policy means moving some taxes or elements of public spending up or down to either propel or restrain total spending. In the United States, such decisions are made politically, by Congress and the president. Monetary policy normally (but not now) means lowering or raising short-term interest rates to either speed up growth or slow it down. That power, of course, resides in the technocratic Federal Reserve.

In 2008 and 2009, the U.S. government rolled out the heavy fiscal and monetary artillery to stave off Great Depression 2.0. Taxes were cut, spending was increased, and the Fed pushed the federal-funds rate all the way down to virtually zero. It worked.

But that was then and this is now. Today, the economy still needs a boost. But we seem to be trapped in what I call the paradox of macroeconomic policy: The policies that might work won't be tried, and the policies that will be tried might not work. If that sounds irrational, well, you've got the message.

There are plenty of powerful weapons left in the fiscal-policy arsenal. But Congress is tied up in partisan knots that will probably get worse after the election. On the other hand, the Fed stands ready—indeed, seems eager—to act. But it has already deployed its most powerful weapons, leaving only weak ones. That's the paradox.

How might fiscal policy speed up growth? As Elizabeth Barrett Browning once said, let me count the ways. Actually, let me not, because there are too many. Here are just three of my personal favorites:

• New jobs tax credit. ...
• Government hiring. ...
• Cut sales taxes. ...

...

Don't get me wrong. The two main thoughts that are probably going through Mr. Bernanke's head today are, first, "I sure wish I could get some help from fiscal policy," and second, "I probably can't, so I'd better do whatever I can." He's right on both counts.

In a more rational world, it wouldn't be this way. Fiscal policy, which packs the power, would be doing the heavy lifting—by combining tax cuts and spending today with credible deficit reduction for the future. Monetary policy would take the back seat by keeping interest rates low. But we don't live in a rational world. And as Donald Rumsfeld might have said, you go to war against recession with the army you have. Right now, that's the Federal Reserve. The fiscal army is AWOL.

Mr. Blinder, a professor of economics and public affairs at Princeton University and vice chairman of the Promontory Interfinancial Network, is a former vice chairman of the Federal Reserve Board.